The Big Short – Intellectual Stamina

A musing on what successful value investing and technology start-ups both require

After a long West Coast trip last month, I was ready to relax on the long plane ride back to New York City. I settled into a glass of wine and decided to watch The Big Short, the movie of Michael Lewis’s book by the same name, which I had previously read and enjoyed. As this movie about the housing bubble and its popping unfolded, I was taken by the gut-wrenching endurance required of the few investors who saw the coming crash and tried to profit. It resonated with my own experiences regarding the intellectual stamina required from both value investors and technology entrepreneurs along the road to success.

Quick Synopsis of The Big Short

Through a variety of forces in government and on Wall Street, mortgage standards loosened to the point where two things happened. First, the prices of homes materially increased. Second, individuals bought houses they could not afford on the backs of loans they would be unable to repay unless home prices kept rising. It was, of course, generally accepted wisdom that housing prices never declined. Therefore, the consensus view was that securities that consisted of bundles of mortgages were very safe investments.

This view may not have been so dangerous, but, as the movie describes in vivid and simple ways, the risks associated with these mortgages were multiplied into explosive proportions through credit derivatives. When the underlying mortgages began to fail, the foundation of these derivative products — and the housing bubble they enabled — began to crack. At that moment, more than $500 trillion (or 100 times the world’s GDP) of these products infected the global financial system. The rest, as they say, is history.

While few investors identified the problem and opportunity that was in the making, several saw clearly the house of cards that was the housing market. Three of them are profiled in The Big Short, and I was riveted by the incredible stamina required from each one to see his investment thesis through to its conclusion.

For example, because everybody “knew” that mortgage-backed securities were safe investments, the investors highlighted in The Big Short were literally laughed at by the banks that helped them bet otherwise. Then, as they experienced early losses on their bets, their limited partners sued them and demanded the return of capital. Throughout the movie, they had to wrestle with the pain of believing they were right while all of the feedback — from their results, from their peers, from their investors — suggested that not only were they NOT right but that they were crazy as well.

While The Big Short investors prevailed and ultimately realized eye-popping gains, I wonder how many others correctly saw the opportunity but did not have the staying power to see their investments through.

“I'm convinced that about half of what separates the successful INVESTORS from the non-successful ones is pure perseverance.”

The above quote is from Steve Jobs, although he actually said it a little differently. His actual quote uses “entrepreneurs” and not “investors.” But as you can see, its gist applies pretty well to the group of investors who bet that the housing market would eventually fall.

Why This Resonates: For a Value Investor & Tech Entrepreneur

In the movie, there is a scene when Michael Burry (played brilliantly by Christian Bale) is in his basement playing his drums and blasting heavy metal. He’s trying to calm himself because what he is going through is almost unbearable. His bets that the housing market would plunge are proving to be way too premature, and his results are terrible. He closed 2006 with a return of -18%, while the market was up more than 10%. His investors were not happy!

At that moment, I had a flashback to 1997. This was before John and I started Euclidean, back when we were aspiring entrepreneurs trying build Employease, a pioneer in software-as-a-service (SaaS) as applied to HR technology. We were approaching the finish line in raising our first VC investment, and we had a few term sheets, one of them from Bill Gurley, then a new partner at Hummer Winblad. I remember sitting with Bill and his partner Ann Winblad at a restaurant named Il Vagabondo in New York City, which is distinctive because you can play bocce there as you wait for your food. Bill is now pretty well known, but Ann was already a rock star then. She was among the first women founders of a software company, and she profitably built hers into a business worth millions. Then she dated Bill Gates for many years, knew everyone in the industry, and funded a number of Silicon Valley’s leading software entrepreneurs.

So I remembered asking Ann what, in her experience, separated successful and unsuccessful entrepreneurs. I will never forget the essence of what she said. It went something like this:

Entrepreneurs come with a variety of styles. On one hand, you have the Michael Dells of the world, who are world class at surrounding themselves with great people and building on their ideas. On the other hand, you have the Larry Ellisons, maniacal founders with huge egos who aren’t great at listening to others. You can find successful entrepreneurs across that spectrum. But what all successful entrepreneurs have in common is intellectual stamina. That is, they are passionate about their vision for their business. But then they take a few steps forward and realize that much of their vision isn’t going to play out as they imagined. Successful entrepreneurs don’t skip a beat when this happens. They take the core of what remains, recast their vision around that core, and proceed apace. Successful entrepreneurs may have to do this 10 to 15 times across the course of a venture.

John and I refer to this as Ann’s concept of Intellectual Stamina. It’s simple and wise, although it doesn’t fully capture how stressful and soul-testing the process can be. Elon Musk probably gets more directly to that element when he says, “Starting a company is like eating glass and staring into the abyss.” Even so, her words stuck with us because they foreshadowed all of the incredibly stressful tests of our perseverance that came over the ten years we built our first company, across the dot-com boom and bust, to a successful outcome.

A partial list of those tests: We had a third founder whose departure was complicated and left the company unsteady. We had three moments when we came within weeks of not having enough cash to fund payroll. To survive the dot-com bust, we had to dramatically cut expenditures and go from 130 to 80 people. We had to iterate through our sales model three times before we got it right. We had a Fortune 500 company purchase a competitor, and we had to battle for five years against that company’s 800 salespeople. We had to navigate all of these challenges and more before we won our little niche.

But Ann’s wisdom applies to more than just the entrepreneurial experience, and it is starting to look a little more universal than we initially realized. It also captures what has since been required of us at Euclidean and, I think, what is required of all successful investors. Like the successful entrepreneurs in Ann’s experience, successful investors don’t always look as if they are winning. They endure periods of tough performance, even when their approach is on track to deliver strong long-term returns. This is what occurred with the investors in The Big Short. They had a vision that would ultimately prove to be true. But the road to realizing that vision came with unforeseen twists and incredible obstacles. Most investors who set out on that road probably bailed before the finish line. The great story about — and the success of — The Big Short investors came because they endured.

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